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Be Careful With Lululemon Athletica Ahead of Earnings

Vince Martin

I’m not betting against Lululemon Athletica (NASDAQ:LULU) at this point. I wouldn’t recommend anyone else do so, either. LULU stock has risen 150% from November lows — and the gains have been deserved.

Lululemon has been performing exceedingly well, including a ridiculous 20% same-store sales increase in the first quarter. As Will Ashworth detailed, the company made a strong choice in new CEO Calvin McDonald. Athleisure remains hot in the U.S., and international growth is torrid.

Indeed, even I — a longtime retail bear — came around to the LULU story after the company’s Q4 report in March. But LULU stock has tacked on 70% gains since then. And as much as I like the company, and the story, I see some reason for caution, at least, ahead of Thursday afternoon’s fiscal Q2 report.

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The Case for LULU Into Earnings

The case for buying — or keeping — LULU stock into earnings is relatively simple. Don’t fight the tape, or the trend. The company is performing exceedingly well, and there’s no reason to see that trend changing. Indeed, last week, Gap (NYSE:GPS) cited a strong quarter for its Athleta brand. That bodes well for Lululemon, given its much larger reach and far stronger sales.

LULU stock does look expensive. It trades right at 40x, the midpoint of fiscal year 2018 (ending January 2019) earnings-per-share guidance, backing out about $7 per share in cash. But that guidance also suggests at least 20% EPS growth this year. And with a huge opportunity overseas, growth isn’t going to decelerate as quickly it might for a U.S.-only retailer. Same-store sales in Asia rose over 50% in Q1, per the first-quarter conference call. The international opportunity means Lululemon can continue to grow for some time to come.

From a short-term perspective, meanwhile, expectations don’t seem that high. Street estimates suggest 15% revenue growth — against a 25% increase in total sales last year. Consensus EPS projections of 49 cents imply 26% growth year-over-year after a 72% increase in Q1 to come in ahead of expectations, Lululemon’s second-quarter earnings don’t have to be nearly as spectacular as the first-quarter numbers were.

All told, this is, at worst, a good company performing well. There’s no clear reason to exit now.

The Reasons for Caution

That said, there are some reasons to think that Thursday’s report might be a bit of a trap for LULU stock. For one, Lululemon does have a much tougher comparison. The year-prior quarter in Q1 was much softer, with comps actually down 1% and EPS up just 6%.

This time around, Lululemon is comparing against 7% same-store sales growth, a figure boosted by an online sale. On the bottom line, the compare remains soft: EPS actually declined year-over-year in Q2 FY17. It’s not hard, however, to imagine a narrative in which Lululemon beats on earnings — but weaker-than-expected comps bring the stock down.

The other issue is that simply meeting or beating the Street might not be enough. Again, the stock has risen 150% in less than ten months. It’s gained 15% just since late July. Expectations likely are something close to sky high, at least.

Full-year EPS consensus estimates, meanwhile, already are above guidance, at $3.24 against the company’s range of $3.10-$3.18. A “beat-and-raise” quarter, in other words, may not be enough. Lululemon is going to have to raise its expectations significantly to surprise the market to the upside.

And we’ve already seen a few retailers this season — among them Hibbett Sports (NASDAQ:HIBB), Fossil (NASDAQ:FOSL), and JC Penney (NYSE:JCP)  — take a big hit following earnings. Lululemon is a very different — and much better — company and stock, obviously. But with the sector and the stock soaring, it doesn’t take much to stumble.

LULU Stock Sounds Familiar

All told, I do see some reason for caution in LULU stock — both this week and long-term. But the story here does sound awfully familiar. In a market at all-time highs — and up 400%+ from crisis-era lows — there have been so many stocks that seemingly had run too far, too fast.

In most of those cases, investors were rewarded for sticking with the story — and the trend. Good companies can grow into their valuations — particularly in a bull market. That’s the best reason to simply tune out the noise and stay long LULU this week, and beyond. But it will take a very strong quarter for Lululemon to post more gains on Friday.

As of this writing, Vince Martin has no positions in any securities mentioned.

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